It’s 2018: Do you know what your tax rate looks like? The Tax Jobs and Cuts Act (TCJA) was signed into law last year, with the promise that most taxpayers would get a tax break. However, the General Accounting Office (GAO) is warning that, unless taxpayers act to adjust their withholding, more than thirty million taxpayers will owe taxes next year, an increase from last year (report downloads as a pdf).
Why the confusion? In addition to the new tax rates, the TJCA made significant changes to itemized deductions normally claimed on Schedule A. Those changes include limits on the deductions for state and local (SALT) taxes, a cap on the amount that you can borrow for purposes of the home mortgage interest, and exclusions for job-related expenses.
(You can see what your Schedule A might look like here.)
As a result, the Internal Revenue Service (IRS) has encouraged taxpayers who itemize to do a checkup on their taxes (find out more here). By plugging your current tax data into the withholding calculator on the IRS website, you can do a “paycheck checkup” and avoid surprises at year-end.
But just doing a checkup isn’t enough: You may need to take additional steps. Generally, employers are required to withhold income taxes on employee pay, but employees can exclude part of their pay from withholding. You typically do this by completing a form W-4 to help your employer determine how much federal tax to withhold from your paycheck. If you withhold too much, you are due a refund; if you withhold too little, you will owe at tax time. The key is to try and maintain a balance.
As a result of the new tax rates, the IRS published new withholding tables for employers, together with a new form W-4. (You can find out more about updating your form W-4 here.)
To measure how the new tables might be working in connection with the updated rates, the GAO conducted a “performance audit” from February 2018 to July 2018. They found that taxpayers are likely not withholding the proper amounts from their paychecks.
Typically, most taxpayers over-withhold. That’s encouraged by the feds because it means that there is less likelihood of noncompliance; the IRS has estimated that 99% of income subject to withholding, like wages and salaries, is accurately reported.
During the last tax season, IRS processed more than 135 million individual tax returns, not including extensions. Over the same time, the IRS issued more than 102 million refunds, representing about 75% of taxpayers. If the law had not changed, those numbers were expected to hold for the 2018 tax year. However, with the changes, the GAO expects that the percentage of taxpayers with wages with over-withheld tax will decrease, while the percentage of taxpayers with wages with under-withheld tax will increase. The percentage of taxpayers with wages with accurately withheld tax (within $100) is expected to remain the same. If the anticipated statistics play out, that means that close to 32 million taxpayers will owe tax in 2019 (21% of the more than 150 million taxpayers, including extensions, expected to file based on prior data).
Who is most at risk for missing the sweet spot? A GAO analysis of hypothetical taxpayers suggests that those most likely to over-withhold as compared to last year are married, single-wage earning middle-class married taxpayers with two children, who claim the standard deduction. Those most likely to under-withhold are married, single-wage earning upper-middle-class taxpayers with two children, who itemize their deductions and report additional non-wage income like dividends and interest.
To help address the issue, the Treasury Department intends to make additional changes to the withholding tables in 2019. The IRS is also updating the form W-4 (again): The one which was released in early 2018 was focused on quick and simple updates. Recently, the IRS issued the first draft of a more complicated form W-4 for 2019 which allows employees to specify the number of deductions they plan to take or credits they intend to claim, as well as other income they expect to earn. That makes things more complex for employers (and payroll services) but should result in a more accurate withholding for 2019.
Until that time, how can you avoid getting stuck with a big tax bill?
- Do a tax checkup (more on how here).
- Consider revising your form W-4 (find out what you need to know here). Here’s your rule of thumb: The more allowances you claim, the less federal income tax your employer will withhold from your paycheck (the bigger your take-home pay). The fewer allowances you claim, the more federal income tax your employer will withhold from your paycheck (the smaller your take-home pay).
- Pay attention to income not subject to withholding, like dividends and interest – and that gig income (more on reporting side gig income here).
- Stay up to date. It’s important to remain informed, so follow a trusted tax column (like this one) or another source, so that you can make changes as necessary.
- Consult with your tax professional.
